Draft Financial Services Bill - Draft Financial Services Bill Joint Committee Contents

Executive Summary

In autumn 2008, Britain's banking system came perilously close to collapse. To avert catastrophe, the Government was forced to step in with multi-billion pound bailouts. Many factors led to this crisis including failings in financial supervision and fuzzy allocation of responsibilities for preventing and managing systemic crises.

The draft Financial Services Bill is aimed at preventing such a potentially calamitous systemic failure of the financial sector occurring again. It proposes far reaching changes to the regulatory structure, replacing the tripartite system of financial regulation with a twin peaks model. Our recommendations are intended to ensure that the new regulatory authorities have the right objectives, powers and responsibilities and systems of accountability which will be essential to make them effective.

The draft Bill gives unprecedented new powers to the Bank of England. The Bank will now have substantial powers to manage the British economy not only through monetary policy but also by directly influencing risk-taking in financial markets and influencing the supply of credit. It will have access to measures impinging directly on households and businesses. This raises important issues of democratic accountability to Parliament. We make recommendations to ensure that the Treasury and Parliament will exercise more oversight of the new Financial Policy Committees' macro-prudential activities. The Bank's powers also demand a new governance structure for the Bank itself and we recommend that the Court of Directors be replaced by a Supervisory Board, some members of which would have direct experience of the financial sector. The new Board should have powers to review the performance of the new Financial Policy Committee and its chairman would be consulted on the appointment of a new Governor.

The new Financial Policy Committee should become a committee of the Bank under the new Supervisory Board, with equal status to the MPC. FPC membership must be broadened to include experts from across financial services, including insurance, and the wider economy. Bank of England staff should lose their proposed majority on the FPC to external members. Reports on major regulatory failure, like the recent report of the collapse of RBS, should be standard practice. The PRA should have an independent complaints commissioner who handles complaints against both the PRA and the FCA.

It must be clear, however, that if there is a potential banking failure, and the possibility of demands on the public finances, then it is a matter for Government. The evidence we received made clear that in the last crisis, there was confusion as to who was in charge. Our recommendations intend to remove any doubt: when there is a threat to public funds, the Governor must alert the Chancellor who must then lead the response.

No regulatory structure can completely rule out bank failure but the likelihood and potential impact can be minimised. The Independent Commission on Banking's recommendations on ring-fencing of retail banking from riskier investment banking arms should receive thorough pre-legislative scrutiny. Subject to that we recommend that legislation enacting the proposals on ring-fencing should be brought forward in the next session of Parliament, with a view to implementation at the earliest possible date. The Government should think very carefully about imposing on banks headquartered in the UK capital requirements relating to their overseas subsidiaries over and above that agreed by the international college of regulators monitoring those banks.

The financial sector, however, now extends far beyond the ranks of banks. MF Global, the recently failed US futures broker, would not have come within the regulatory perimeter as envisaged for the new Prudential Regulatory Authority. This is not acceptable. The regulatory perimeter of the PRA should be widened to cover investment firms of the size and significance of MF Global; it should be flexible with changes subject to an enhanced form of parliamentary scrutiny. The PRA's objectives in the draft Bill restrict its supervision to firms that pose a threat to the entire financial system. This is too limited—the PRA should have a secondary obligation to reduce the risk of failure of other financial firms which can burden the financial guarantee scheme, inconvenience, and potentially impose losses on, customers. The regulation of market infrastructure should sit within the PRA.

We recognise the international nature of the financial sector and the fact that the European Union imposes an increasing amount of the regulatory framework. The new regulatory structure in the UK does not mirror the EU regulatory structure and with different bodies representing the UK at different international negotiating tables there is a danger that the UK will not speak with one strong unified voice. We recommend a high level committee reporting to the Chancellor and comprising representatives from the PRA, FCA, Bank and Treasury to agree British objectives and maximise the UK's influence in EU and international negotiations.

In recent years there have been several cases of mass mis-selling of financial products, such as Payment Protection Insurance. The draft Bill establishes a new conduct of business regulator: the Financial Conduct Authority (FCA). The FCA's obligation in the Bill to promote confidence in the UK financial system could encourage it to conceal or ignore weaknesses that might disturb confidence. The FCA's objective should be to focus on promoting fair, efficient and transparent financial services markets that work well for users. The FCA should be given significant new competition powers including the power to make market investigation references to the Competition Commission and the power to hear super-complaints. Responsibility for consumer credit should be moved from the OFT to the FCA.

To complement the principle of 'caveat emptor' enshrined in the draft Bill a statutory duty should be placed on firms to treat their customers "honestly, fairly and professionally", and the FCA should ensure that companies address conflicts of interest and provide intelligible information, rather than accurate but impenetrable information that leaves customers confused. Customers have a right to know if a warning notice has been issued about a firm's product or process so the requirement for the FCA to consult before disclosing the fact should be removed from the draft Bill. We also make recommendations to ensure bank customers are made aware when, because their bank is headquartered elsewhere in the EEA, their deposits are not covered by the Financial Services Compensation Scheme.

The previous regulatory regime focused too much on backward-looking mechanistic rules and did not anticipate the evolving risks that threatened the financial system. An important aspect of the new regulatory philosophy and culture therefore will be 'judgment-led' supervision—which means being more forward-looking in anticipating the risks that threaten the regulatory objectives of financial stability, consumer protection and market integrity. Despite the Government's claim that the new regulatory approach will be based on 'judgment-led' supervision, the term is not mentioned in the draft Bill. We propose that 'judgment-led' supervision be given statutory backing.

The culture and ethics within the financial services industry also need to change. Before the 2007 crisis many banks appear to have been involved in practices that were unethical and designed to maximise remuneration regardless of risk to the bank let alone the economy. Supervisors, banks and shareholders must ensure that senior staff remuneration schemes do not lead financial institutions to take on excessive risk. The PRA and FCA should take an active interest in this area and should rigorously enforce the remuneration code. The Government and the regulators should consider increasing the share of executive remuneration that is deferred and conditional on medium term outcomes, or introducing a concept of 'strict liability' of executives and Board members for the adverse consequences of poor decisions, in order to ensure that bank executives and Boards strike a different balance between risk and return.

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© Parliamentary copyright 2011
Prepared 19 December 2011